Mutual Fund Flow Timing and External Growth
Hong Zhang, INSEAD
23rd Jul 2010 10:30 am - Meeting Room 7, Darlington Centre School Building
The literature documents a convex relationship between performance and subsequent fund flows and argues that this convexity helps managers to attract more flows by raising fund level risk. Due to an adding-up constraint which aggregates flow-performance relationship at the industry level, however, empirically estimated convexity must be correlated with aggregate flows. This correlation provides incentives for managers to pursue a time-varying "flow timing" strategy, that is, to increase risk only when they forecast a big, positive aggregate flow, in order to benefit from the flow-performance convexity in periods when its value is the highest. Empirically, superior flow timing ability helps funds to attract additional external flows. In contrast, increasing fund risk without timing ability does not appeal to new flows.